Accounting Discretion, Loan Loss Provisioning and Discipline of Banks' Risk-Taking

Bushman, Robert M.; Williams, Christopher D.

doi:10.2139/ssrn.1521584

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Accounting Discretion, Loan Loss Provisioning and Discipline of Banks' Risk-Taking

Journal of Accounting & Economics (JAE), Vol. 54, Issue 1, pp. 1-18, August 2012

48 Pages Posted: 11 Dec 2009 Last revised: 17 Jan 2013

See all articles by Robert M. Bushman

Robert M. Bushman

University of North Carolina Kenan-Flagler Business School

Christopher D. Williams

University of Michigan, Stephen M. Ross School of Business

Date Written: April 25, 2012

Abstract

Examining banks across 27 countries, we estimate two measures of the forward-looking orientation reflected in discretionary loan provisioning practices within a country. We document that forward-looking provisioning designed to smooth earnings dampens discipline over risk-taking, consistent with diminished transparency inhibiting outside monitoring. In contrast, forward-looking provisioning reflecting timely recognition of expected future loan losses is associated with enhanced risk-taking discipline. Thus, proposals to change loan loss accounting embed significant risks of unintended consequences, as gains from reducing pro-cyclicality may be swamped by losses in transparency that dampen market discipline and increase the scope for less prudent risk-taking by banks.

Keywords: Smoothing, Timeliness, Accounting Quality, Loan Loss Provisions, Discretion, Risk, Banks

JEL Classification: E58, G21, G32, M41

Suggested Citation: Suggested Citation

Bushman, Robert M. and Williams, Christopher D., Accounting Discretion, Loan Loss Provisioning and Discipline of Banks' Risk-Taking (April 25, 2012). Journal of Accounting & Economics (JAE), Vol. 54, Issue 1, pp. 1-18, August 2012, Available at SSRN: https://ssrn.com/abstract=1521584 or http://dx.doi.org/10.2139/ssrn.1521584